The disconcertingly bright 44-year-old Australian who climbed from modest origins as the son of a surveyor living in Montville, Queensland, to run $US80 billion of global equities, cash and gold based in New York is almost completely unknown in domestic investment circles.

None of the scores of hedge funds, super funds, asset consultants or family offices consulted by AFR Weekend had ever heard of the modest, baby-faced polymath,
Matthew McLennan
.

Nor were any familiar with the discreet, family-owned
First Eagle Investment Management
where McLennan works, which was George Soros’s home for the first 10 years of his career.

This is probably because the proud Australian has avoided ever giving a media interview here. The only reason Weekend AFR stumbled across him was care of an off-the-cuff reference by a former University of Queensland colleague,
Richard Howes
, who is chief executive of Challenger Life.

Howes recalls the “cerebral" university medallist in finance, with whom he briefly worked at the Queensland Investment Corporation, was “in a different league — even among his honours peers".

He describes McLennan as a “scientist in an industry overcrowded with businessmen".

So what investment lessons has Australia’s biggest funds management export accumulated along his circuitous, personal and professional journey, which began with six years living in Papua New Guinea? He agreed to talk only on the basis we mention Advance, which is a not-for-profit entity representing the Australian professional diaspora that McLennan supports.

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Long history

First Eagle, which traces its genesis back to 1803, has expanded on the back of 30 years of solid performance in the global equities space. The core Global Value Fund McLennan manages has returned 14.7 per cent annually after fees since its inception in 1979, or 5 per cent each year above its benchmark.

One of the common mistakes investors make is to attribute successful results to skill, and neglect the role that providence plays in every human endeavour.

Asked about the biggest setback he’s faced, McLennan says “the toughest moment in my career was during the late 1990s as a ‘value’ investor where the tech boom made us all feel like dinosaurs," he said.

“We could not find the valuation margin of safety. I was watching our assets under management shrink – it was one point where I felt my job was genuinely at risk.

“As a long-term value investor, you have to be willing to be ‘short’ on social acceptance from time to time," he said.

McLennan’s faith in the merits of a “bottom-up" and fundamentals-focused investment strategy would eventually serve him well.

In 2002 he was appointed a managing director at
Goldman Sachs
at the young age of 33.

Indulgence

He says that demonstrating that resistance to an “almost overwhelming market indulgence" was crucial to being hired by First Eagle. A second formative experience was landing at First Eagle in September 2008, a week before Lehman Brothers filed for bankruptcy. McLennan conceded the wild asset price gyrations presented him with “stark moments of uncertainty because markets were on the brink.

“On the other hand, it was a blessing in disguise to come in and head a team at that juncture because it helped unify us all around the principles of conservative underwriting.

“The most dangerous environments are late in the cycle when hubris creeps in," he says.

“And while we might sound like undertakers, there were times during the crisis when there was a tingle of excitement.

“We think the best way to produce real returns over the long term is to own good businesses at good prices. And in a window of true distress you are like a kid in a candy store – you can go in and buy the businesses you want with a wide valuation margin of safety if you are willing to take a long-term view."

McLennan’s strategy is distinguished from “growth" managers hunting for companies with high future earnings potential and more concentrated “high conviction" styles that are popular in his value space.

Popping corn

“We never think we can predict which one of our stocks is going to work best. It is kind of like cooking popcorn – you expect most are going to pop, but don’t know when. And a few will burn out.

“We’ve never been a believer in concentrated value portfolios because they presume an ability to divine an individual company’s future.

“What we do try to do is buy businesses that have ‘persistence’ or franchise duration.

“We love businesses that have been around for a long time. Businesses that have things that ought to make them persist – relative scale advantages, customer captivity and so forth. We are mindful that a business that can take market share quickly can lose it quickly.

“So we look for evidence of historic durability in a company’s market position. And we like to pay low multiples for cash flow around the single-digit multiples of earnings before interest and tax. When we invest we are not paying for growth – we’re ideally getting that for free."

He says First Eagle’s $80 billion is “weighted around 70 per cent to global equities, a bit over 20 per cent in cash as a source of deferred purchasing power in both market crises and deflationary scares, and just under 10 per cent in gold bullion and gold equities as protection against inflation". Investing in gold mines is cheaper than buying the chemically inert commodity outright, he claims.

Impossible forecasts

McLennan’s method touches on a meme fostered in these pages: recognising the impossibility of forecasting the future in a world where pundits pretend they’re Leonardo da Vinci.

He says that embracing this principle “totally changes the way you invest because it makes you hunt for a margin of safety in your investments rather than trying to leverage yourself to one specific view".

“We are dealing with complex systems, which are being amplified today. We don’t currently have normal unfettered economic forces at work – we have a distorted financial architecture," he says.

“And there is a complicated and polarising geopolitical equilibrium that you need to layer on top of that. Finally, few people understand that a lot of the change that happens in the world is attributable to innovation – that is, new ways of doing things – which by definition is very hard to anticipate," he says.

McLennan perceives deep flaws in the global financial system that are creating asset pricing distortions that could perpetuate periods of high inflation or deflation.

Liquidity

“Originally, central bankers would provide liquidity as a means of last resort. Now we have created a world that is addicted to central bank liquidity," he says.

“My problem is that governments have never really let the global economy ‘clear’, or rectify the savings and investment imbalances between creditor and debtor countries that caused the 2008 problems in the first place," he says.

Record low rates and unparalleled government purchases of privately traded assets have led to us “obfuscating and amortising the structural adjustments we need to have", he says.

“The underlying concern is that you have had a series of ‘fake prices’. First, the price of money has been faked through central banks lowering interest rates to artificially low levels. Second, the most important exchange rate in the world – between the US dollar and the Chinese renminbi – has been a quasi-pegged currency."

White elephant

The US dollar reserve standard has led to “white elephant malinvestment in creditor countries like China with excess construction and manufacturing capacity that wouldn’t have existed were it not for the exchange rate".

In countries running persistent current account deficits, such as Australia and the US, you get “excess credit somewhere in the economy".

“In the US, it was originally in the private sector with the late 1990s corporate boom, and then the residential boom in the mid-2000s. Once the private sector started to deleverage in 2008, all of that debt shifted to the sovereign."

A final asset pricing distortion is manifest in the US yield curve, which is the global benchmark for the long-term price of money. This is being driven by the US Federal Reserve “seeking to buy more bonds than the Treasury is actually issuing".

McLennan concludes the two most important prices in the world – the US treasury yield curve and the US dollar-renminbi cross – are effectively fake prices.

On geopolitical frictions, McLennan says he’s concerned about the possibility of major power conflicts after a period of relative peace since the Second World War, and worries that markets are underclubbing these risks.

“I think the recent period of secular growth has changed relativities and produced new geopolitical insecurities that could create the Balkans of the 21st century," he says.

“The problem is, markets are not pricing in the fault lines triggered by central banks’ financial repression and geopolitical pressure."

The best analogy for today is 1913, or 12 months before the outbreak of the First World War, he says. “That followed a period of strong growth during the Gilded Age in North America and the European La Belle Époque between the 1870s and the turn of the 20th century, which produced imbalances, changes in geopolitical relativities and social norms." In another antecedent to the 2008 ructions, “you also had a large stock market crash in 1907 that was a liquidity induced crisis".

“If you look at the history of war, fear of war is often the cause of it.

“You have Prime Minister Abe speaking publicly in recent weeks about Japan wanting to change its constitution to remilitarise. They’re clearly worried that China is spending twice what Japan is on defence. Meanwhile, the US and Europe are cutting back."